How to Tell If My Bank Is Solvent?
- 1). Look up the book value, or liquidation value, of the bank. This number represents the value of the bank's assets if it were liquidated that day, with assets sold off to pay off all the bank's liabilities and creditors. As a depositor, you are a creditor and a liability on their books. You can find the liquidation value in the bank's financial statements, which corporations must publish each year in their annual report to shareholders. If there is no line item that reads "book value," then you can calculate it yourself from the bank's balance sheet: Book value equals total assets minus total liabilities. If the number is positive, you can be confident you will eventually be made whole -- assuming the bank has accurately assessed the value of its portfolio of loans.
- 2). Determine the current ratio. This number measures the bank's capability to meet expected liabilities over the course of the year. It's important to look at near-term liabilities and assets available to pay them, because even the strongest balance sheet in the world doesn't help the bank if it cannot raise cash in time to pay its obligations. To calculate the current ratio, divide the bank's current assets by its short-term liabilities, i.e., its liabilities due over the next 12 months. When you look at your bank's annual report, you should find short-term liabilities listed as its own line item, as well as total assets.
- 3). Apply the acid test. With this test, you compare the liquid assets of a bank against its short-term obligations. This ratio only takes into account assets that are readily converted into cash, i.e., cash, cash equivalents, readily marketable securities such as treasuries and commercial paper, and permanent life insurance cash value.
- 4). Check the bank's leverage. Banks must maintain a minimum level of cash reserves to meet expected deposits and the occasional loan default or other expense. But they frequently lend out each dollar many times over. The more times they lend each dollar they take in, the more leveraged they are. A 10-to-1 ratio is fairly conservative for banks. At the height of the real estate bubble, though, some banks were leveraged as much as 30 to 1. The higher the leverage, the greater the threat of collapse.
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